HQ 548373 - Internal advice; dutiability of royalty payments - United States International Trade Commision Rulings

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HQ 548373

November 24, 2003

RR:IT:VA 548373 CRS

CATEGORY: VALUATION

Port Director
Area Port of Houston/Galveston
Attn: Field Director, Regulatory Audit Division 2350 North Sam Houston Parkway, Room 1050 Houston, TX 77032

RE: Internal advice; dutiability of royalty payments

Dear Sir:

This is in reply to your memorandum dated July 25, 2003, under cover of which you forwarded a prior disclosure dated January 29, 2003, and a supplement thereto dated March 10, 2003, submitted by the [*********] Division of [******** ****************************], Inc. (the “importer). The prior disclosure concerns the dutiability of certain royalty payments made pursuant to a license agreement between the importer and the [*************************] (“Petra”). In your memorandum you requested internal advice relative to the dutiability of these payments.

The importer has requested that certain information in its submissions be treated as confidential in accordance with19 C.F.R. § 177.2. The request satisfies the conditions for confidentiality set forth in the Customs Regulations. Accordingly, the information will be treated as confidential. Information enclosed in brackets will be redacted from public versions of this decision.

FACTS:

The importer purchases and imports, from [*****] Technologies, certain specialized apparatus and equipment (the “[*******] equipment”) for use in oil and gas drilling operations. The importer pays a royalty to Petra of five percent of its net income from certain drilling operations that make use of the [*******] equipment. Petra is the owner of U.S. Patent [************] (the [*****] patent) covering the method and device incorporated in the [*******] equipment. The importer is not related to Petra, the licensor, or to [*****] Technologies, the seller of the imported merchandise. Petra, through its wholly owned subsidiary, [************], owns 100 percent of [*****] Technologies.

Pursuant to a license agreement dated January 1, 1989, the importer pays Petra a royalty based on the net income derived from pipe conveyed logging (PCL)

In the oil and gas drilling industry, the term “logging” refers to the process of using specialized tools in order to measure and record, i.e., “log,” certain parameters and characteristics of the subsurface formations of a well. The [*******] equipment incorporates a patented process for effecting logging operations in a predetermined inclined or horizontal zone of a well. related operations which utilize the [*******] equipment. In this regard, the license agreement provides in pertinent part:

[*********************] Division of [***********************], Inc., now [*****************]. agrees to pay to [******] a royalty based upon net income from PCL related operations, which specifically makes use and application of [*******] equipment, for each and every logging operation conducted during the term of this Agreement by [*******] to its customers. Said royalty on NET invoice shall include basic charge, standby charge, depth charge and survey charges for other equipment, or services not related to actual use of [*******] equipment.

License Agreement, art. II, para. 2. The importer pays the royalties to Petra on an annual basis. The agreement provides further that after the expiration of the initial leasing period, [********] is the only party responsible for the use of the [*******] sets that become its property. Id., art. V.

Although the importer now purchases [*******] equipment from [*****] Technologies, it originally leased the [*******] equipment from Petra. The 1989 license agreement provided that Petra would make replacement parts available, that such parts would feature the latest [*******] technology and that following the one year lease period, the [*******] equipment would become the property of the importer. The agreement provided further that Petra would supply technical assistance. Finally, the parties agreed that Petra could assign the license agreement to one of its subsidiaries on sole written notice to the importer provided that the subsidiary agreed to assume all Petra’s obligations under agreement. Appendix 1 to the license agreement describes the [*******] equipment and is part of the agreement “for all purposes.”

ISSUE:

The issues presented are: (1) whether transaction value is the appropriate method of appraisement; (2) if so, whether royalties paid by the importer for the [*******] equipment are included in transaction value; (3) if included, how the amount of future royalty payments should be determined.

LAW AND ANALYSIS:

Merchandise imported into the United States is appraised for customs purposes in accordance with section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U.S.C. § 1401a). The primary method of appraisement is transaction value, which is defined as “the price actually paid or payable for the merchandise when sold for exportation to the United States,” plus amounts for certain statutorily enumerated additions to the extent not otherwise included in the price actually paid or payable. The additions include any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of sale of the imported merchandise for exportation to the United States, and the proceeds of any subsequent resale, disposal or use of the imported merchandise that accrue, directly or indirectly, to the seller. 19 U.S.C. § 1401a(b)(1)(D)-(E). If, for any reason, sufficient information is not available in respect of the additions to the price actually paid or payable, the transaction value of the imported merchandise is treated as one that cannot be determined. 19 U.S.C. § 1401(b)(1).

Dutiability of the Royalty Payments

The [*******] equipment is purchased and imported by the importer and used in logging operations. In addition to the invoice price, the importer pays a royalty based on the net income derived from its logging operations that use the equipment. The royalty is paid to Petra, a party related to the seller. 19 U.S.C. § 1401a(g). As general matter, royalty payments may be included in transaction value as part of the price actually paid or payable, or as an addition thereto under section 402(b)(1)(D)-(E) of the TAA. Royalties may also be dutiable, e.g., under section 402(c) of the TAA. 23:6 Cust. B. & Dec. at 5-7. General Notice, “Dutiability of Royalty Payments,” 23:6 Cust. B. & Dec. 1, 11 (February 10, 1993); see also Statement of Administrative Action, H.R. Doc. No. 153, 96 Cong., 1st Sess., pt 2, reprinted in, Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 (October 1981), at 48-49 (the “General Notice”). The General Notice identified three questions as being relevant in determining whether royalty payments are dutiable. Was the imported merchandise manufactured under patent? Was the royalty involved in the production or sale of the imported merchandise? Could the importer buy the product without paying the fee? Affirmative answers to the first and second questions, and a negative response to the third, point towards dutiability. 23:6 Cust. B. & Dec. at 9-11.

However, before examining the dutiability of the payments with specific reference to the provisions for royalties and proceeds, we note once again that the royalties are paid by the buyer to a party related to the seller of the imported merchandise. As a general matter, all payments made by the buyer to the seller are presumed to be part of the price actually paid or payable. Generra Sportswear Co. v. United States, 905 F.2d 377 (Fed. Cir. 1990). Further, Customs presumes that all payments made by the buyer to a party related to the seller are also part of the price actually paid or payable. However, this presumption may be rebutted by evidence that clearly establishes that the payments are totally unrelated to the imported merchandise. Chrysler Corporation v. United States, 17 Ct. Int’l Trade 1049 (1993). In Chrysler, the court applied the Generra standard and determined that certain shortfall and Special Application fees that the buyer paid to the seller were independent and unrelated costs assessed because the buyer failed to purchase other products from the seller. Inasmuch as the fees were not a component of the price of the imported engines they were not included as part of the price actually paid or payable. In contrast with the result in Chrysler, however, the evidence in this case supports a finding that the royalty payments at issue are a component of the price actually paid or payable.

Here, the [*******] equipment is manufactured under patent, as evidenced by claim 8 of the [*****] patent which provides:

A device for effecting logging or servicing operations with the use of a specialized tool, in a predetermined zone of a bore hole, comprising in combination a first hollow rigid rod at the end of which is fixedly secured the tool, and constructed such that no external conduit extending within the bore hole from the ground surface to said predetermined measuring zone is required for supporting, at its lower end, said string of rods when said device is in use after being assembled, a first electric connector connected to the tool, a string of rods connectable to the upper portion of said first rigid rod, and an electric cable provided at its end with a second electric connector complementary to the first connector for connection thereto, and said string of rods comprising at its upper portion, a sealing member adapted for having the cable slide therethrough into the string of rods, and said second connector is weighted and provided with means for causing it to move downwardly through the string of rods by the effect of a fluid pressure generated inside the string of rods on the second connector, and wherein said sealing member comprises a special sub having a lateral port through which the cable can pass, with said special sub adapted for being mounted on the top of the string of rods, and for being displaced into the bore hole by a distance A through which said tool is to be moved in said predetermined zone.

U.S. Patent [************]. Claims 9-18 of the [******] patent also cover the device that constitutes the [*******] equipment. Thus, the imported merchandise was manufactured under patent. See, e.g., Headquarters Ruling Letter (HRL) 545784 dated June 6, 1995 (royalty on sale of products manufactured using imported patented machine dutiable as part of the price actually paid or payable inasmuch as the payment was inextricably intertwined with the sale of the machine).

The royalty is also “involved in the production or sale of the imported merchandise.” The [*******] equipment is manufactured under patent. Thus, the royalty is involved in the production of the imported merchandise. Moreover, the royalty is paid for the right to use the [*******] equipment. Article II, paragraph 2 of the license agreement states that the royalty is paid based on the net income from each and every logging operation that specifically makes use and application of the [*******] equipment. License Agreement at 4. Further, the license agreement provided not only for the royalty but also for lease payments from the importer to Petra, which in effect represented the purchase price of the original [*******] equipment. The agreement also provided that the [*******] equipment would become the property of the importer after the expiration of the original leasing period. See, 23:6 Cust. B. & Dec. at 10, citing United States v. Rohner Gehrig & Co., 9 Cust. Ct. 591 (1942).

The importer cannot import the [*******] equipment without paying the royalty. For example, article II, paragraph 3 of the license agreement provided in respect of certain equipment that was rented under a prior agreement, that although rental charges were no longer due, the royalty payments were nevertheless required. In addition, the license agreement with Petra covered the original equipment lease by the importer and the provision of spare parts. While the importer now purchases the [*******] equipment from [*****] Technologies, the royalty payments are still made to Petra. [*****] Technologies, the seller, is a wholly owned subsidiary of [***************], which is itself a wholly owned subsidiary of Petra, the patent owner and licensor. The royalty payments are made by the buyer to a party related to the seller, are related to the goods and a condition of sale, and result from a “subsequent resale, disposal or use of the imported merchandise. Therefore, it is our position that the royalty is involved in the sale of the imported merchandise inasmuch as it is paid to a party related to the seller. The payments should be included in transaction value either as part of the price actually paid or payable, or as an addition thereto under sections 402(b)(D)-(E) of the TAA.

Determining the Amount of the Royalty Payments

In determining the appraised value of imported merchandise the appraising officer may use “all reasonable ways and means in his power.” 19 U.S.C. § 1500. Moreover, the Court of International Trade has held that payments can be allocated. Chrysler, 17 Ct. Int’l Trade at 1058. As a general matter, payments should be allocated in a reasonable manner appropriate to the circumstances of the case. See, e.g., 19 C.F.R. § 152.103(e)(1), regarding the apportionment of assists. In Chrysler, for example, the court considered whether to apportion certain tooling payments over the total number of products contemplated to be imported, or over the actual number of items manufactured, holding ultimately that the payments should be apportioned over the total number of engines to be produced.

The payments at issue are made annually, during the term of the license agreement, and for as long as the importer uses the equipment. Assuming that the agreement remains in force, and the equipment is used throughout its useful life, then the amount of the future royalty payments can reasonably be determined taking into account the life of the equipment and the length of the contract. In so doing, you may look to the importer’s books and records, and the manner in which the [*******] equipment is depreciated, provided these are in accordance with generally accepted accounting principles (GAAP). However, as noted above, in determining the value of the royalty stream, the payments should be apportioned to the subject entries in a reasonable manner in accordance with Chrysler and 19 C.F.R. § 152.103(e)(1).

HOLDING:

In conformity with the foregoing, the appropriate basis of appraisement is transaction value as set forth in section 402(b) of the TAA.

The royalty payments are included in transaction value as part of the price actually paid or payable, or as an addition thereto under section 402(b)(D)-(E).

The amount of future royalty payments should be determined using all reasonable ways and means and should reflect the term of the contract and the useful life of the [*******] equipment.

Sincerely,

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